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The role of ownership on control right allocation and compensation contract design

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  • Yu-Hsiu Lin
  • Len-Kuo Hu
Abstract
We propose a corporate control model that deals with control right allocation and compensation contract design. By drawing upon a special feature of human nature, that is the sense of gain and loss affiliated with initial ownership as described by the prospect theory in Kahneman and Tversky (1979), we find that it helps mitigate the inefficiency stemming from the agency problem. In particular, there exists a most desirable level of 'managerial irrationality' that completely offsets the social efficiency loss inflicted by the moral hazard problem. Moreover, less control right should be allocated to outside investors and more compensation should be granted to the manager as the latter reveals more serious concern about his ownership gain and loss.

Suggested Citation

  • Yu-Hsiu Lin & Len-Kuo Hu, 2011. "The role of ownership on control right allocation and compensation contract design," Applied Economics Letters, Taylor & Francis Journals, vol. 18(15), pages 1421-1426.
    • Handle: RePEc:taf:apeclt:v:18:y:2011:i:15:p:1421-1426
    DOI: 10.1080/13504851.2010.541148
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    References listed on IDEAS

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